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Getting a Grip on Taxes Before the Storm Hits

THIS has been a year of financial uncertainty, both here and abroad. But one thing is sure for next year: taxes will definitely be on politicians’ agendas and voters’ minds.

This year, tax advisers agree, was benign in terms of changes to the Internal Revenue Code. But that comes after two tumultuous years. In 2009, tax preparers waited nervously for action on the expiring estate tax that never came. Then, in late 2010 came a jumble of unexpected tax actions: from reinstating the estate tax for this year and next, with a higher exemption level than most tax advisers expected, to extending the Bush-era tax cuts for two more years.

So how to handle these last few weeks of the tax year? As is true every year, taxpayers should run a checklist for everything from selling securities that have lost money to taking advantage of annual gift allowances.

But even then, seemingly straightforward deductions are not always so. The $500 energy tax credit, for example, limits the amount you can deduct for new windows to 10 percent of the value up to $200. In other words, you had to spend $2,000 on windows to get the full window credit.

And charitable deductions can be more broadly defined to include costs incurred while volunteering, said Mark Steber, chief tax officer at Jackson Hewitt, a tax preparation company. “You can’t deduct the value of your time, but you can deduct your out-of-pocket expenses,” he said.

But beyond the usual recommendations, the tax advisers I spoke to stressed that you should use this year to get your affairs in order for what promises to be an uncertain two years of tax policy.

“For high-net-worth individuals, chances are the next year or so is going to be a challenging time,” said Chris Johnson, head of United States wealth advisory at Barclays Wealth. “There is going to be a lot of attention focused on ways to extract additional tax dollars.”

If Congress does not act to extend a series of smaller tax deductions, next year could be costly for middle-income taxpayers as well. Here are some of the more pressing issues to consider.

WHAT MAY EXPIRE AFTER 2011 Every year Congress passes a series of so-called patches, renewing some 70 tax breaks for another year or two. In the past, this has been a formality, much as raising the debt ceiling used to be. This year, it remains to be seen what Congress will do.

Mark Luscombe, principal federal tax analyst at CCH, a publisher of research and software for tax lawyers and accountants, noted that when these patches expired in 2009 and were re-enacted retroactively at the end of 2010, the delay wreaked havoc with tax planning.

Other patches affect broader swaths of the population. One allows residents to choose between deducting state income and sales tax against their federal tax. This is a favorite of people in states like Florida and Texas that have no state income tax.

In high-tax states, the big worry is what happens to the alternative minimum tax, a parallel system of taxation that cancels out many deductions. The A.M.T. was originally meant to keep wealthy people from paying too little in taxes. Because it was not indexed for inflation, however, Congress has had to approve periodic fixes to keep it from affecting many more people than intended.

Without a fix next year, Stephen A. Baxley, director of tax and financial planning at Bessemer Trust, said, the A.M.T. would “hit an additional 20 million people, and most of them are middle-income taxpayers.” It normally claims around four million taxpayers.

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Chris Johnson, head of the United States wealth advisory unit at Barclays Wealth, sees “a challenging time” ahead.Credit
Ozier Muhammad/The New York Times

Two of the big triggers for the A.M.T. are high state taxes on property and income, which hit residents of New York, New Jersey, Connecticut and California disproportionately, said Alfred Peguero, partner in PricewaterhouseCoopers’s private company services practice.

For older people, there is again a chance that the provision allowing them to directly donate the required minimum withdrawal from their retirement account to charity may be delayed or not renewed. Currently, people over 70 1/2 can donate up to $100,000 to charity. If this patch were to disappear, the federal income tax on the withdrawal and the charitable deduction would cancel each other out. But some states do not allow charitable deductions above a certain income, or at all.

“Higher taxpayers have their itemized deductions reduced in New York,” Mr. Baxley said. “In Connecticut and New Jersey, you don’t get any benefit from itemized deductions.”

WHAT CHANGES IN 2012 There are several provisions that will take effect or lapse regardless of Congressional action.

One set to start in 2012 is a requirement that brokers report the purchase price on mutual funds and exchange-traded funds to the Internal Revenue Service for capital gains purposes. (They began doing this for stocks this year.)

The default method of reporting is called “first in, first out,” which could result in higher capital gains taxes if those first shares were much cheaper than more recent ones. Taxpayers have the option of electing other reporting methods, like “last in, first out,” which benefits people who bought shares over many years, presuming those shares have appreciated.

There are also two significant tax breaks set to end. One is a loophole that allows people whose marginal tax bracket is under 15 percent to pay no capital gains tax when selling securities held for more than a year.

“It’s been around for three years now but people aren’t aware of it, generally because when their income is that low they don’t have the ability to buy things that appreciate,” said Glenn Frank, director of investment tax strategy at Lexington Wealth Management.

But he said that parents could give $26,000 of appreciated stock as a gift to, for example, a child who has moved home after college and has a low-paying job. (The 15 percent bracket ends at $34,500 for a single person but stretches to $69,000 for a married couple filing jointly.) No taxes would be owed as long as the gains in the securities did not push the recipient’s income out of the 15 percent bracket.

The other break is a provision in the 2010 Tax Relief Act that allowed 100 percent of an investment made in a private company to be free of capital gains taxes. This provision is a boon to venture capitalists who can reap millions in gains tax-free. Mr. Luscombe said he suspected the exemption would revert to 50 percent of the gain.

WHAT HAPPENS IN 2013 In many ways, 2011 may be the calm before the storm. If Congress and President Obama continue to disagree, then the Bush tax cuts automatically expire in 2013, raising taxes on income, capital gains and dividends and lowering the exemptions for estate and gift taxes. Add to this the prospect of an additional 3.8 percent Medicare surcharge on investment income. Then again, the two sides could do something completely unexpected.

The uncertainty means that tax planners are going to have a harder time giving their usual advice — gauging whether it is better to accelerate income and delay deductions or vice versa. Generally, advisers like to have some certainty for two or three years before making a recommendation.

Mr. Peguero said that he would advise business owners “to sell appreciated assets in 2012 and wait until 2013 to make a capital investment where the deduction may mean more.”

He added, “That’s presuming taxes stay the same.”

The uncertainty also means that advisers are spending time urging their clients to remain calm. “I think people can do themselves a great disservice by trying to time the markets and the legislation,” Mr. Johnson said. “You’re opening yourself up to a lot of risk.”

This is where the savviest tax minds cannot compete with politicians bent on getting re-elected.

A version of this article appears in print on December 10, 2011, on page B5 of the New York edition with the headline: Getting a Grip on Taxes Before the Storm Hits. Order Reprints|Today's Paper|Subscribe